In 2001, James Surowiekci wrote a short piece in the New Yorker on how some of today's biggest companies launched in recessions and made it big. Some of them – GM and Sun Microsystems – aren't looking too hot going into this one but, on balance, the list covers some of the biggest hitters of the US economy.
It contained a important lesson for the semiconductor business:
During a boom, it's easier to raise money and easier to sell products. You'd think that would be a good thing if you were trying to start a business. The problem is that everyone else thinks so, too; when the economy is hot, everyone's an entrepreneur. The more companies there are, the less likely it is that one of them will be able to sustain a lasting competitive advantage, no matter how flush the marketplace is. Starting a business is like investing in stock: you want to buy low and sell high. Launching a company in the middle of a boom is the equivalent of buying JDS Uniphase at a hundred and fifty dollars a share. It could go higher, but the smart bet says it won't.
It's been my argument for some time that the number of companies operating in the semiconductor industry, which includes electronic design automation (EDA), that access to money has been pretty easy, particularly for startups. This allowed situations to develop where you had 20 companies vying for a lead position in WiFi, Bluetooth and other markets.
This helped sucked the potential for returns from the venture-capital industry. Talking to foundry TSMC's customers earlier this year, August Capital partner Andy Rappaport showed graphs that, basically, said too much VC money has been chasing too few good ideas. Most of the money flowed into crowded sectors where the probably of individual success was low.
The problem for the semiconductor industry is that the most crowded sectors tend to be those with the highest volume, with one notable exception: PC processors. There, Intel's near monopoly status and willingness to keep it that way has meant companies attracted to the space rarely survive.
Elsewhere, incumbents have been willing to drop prices to maintain high market share in the hope that the smaller players will drop out. Just ahead of the current recession, we saw that process begin in mobile-phone SoCs. Francis Sideco of iSuppli has argued for a while that, to stay in that game, you need annual revenues of $1bn to stay in the game. And, long-term, if you are not in the top three or four, you don't really have a business.
Companies such as NXP Semiconductors realised this and got out, diverting the R&D money to less sexy but probably more profitable areas such as microcontrollers, a market without many VC-funded startups at all. The only sensible buyer for Freescale Semiconductors' own cellphone-silicon business is a larger player or one with the cash and willingness to do a rollup to get into the big league.
We are now going to see the same situation play out in other markets as the VC drought forecast by Sequoia Capital kicks in and other, more established companies decide to get out of long-term loss-making businesses.
In the short term, we are going to see a lot of people put out of work. However, the semiconductor sector that emerges could be in the strongest position since the early 1990s, a period of slow growth but one where prices firmed so well that chipmakers became investors' favourites. It went sour in the overinvestment-glut cycle of 1995-96 but that is something for tomorrow's chipmakers to watch for.
The startups who are able to make it with little to no additional VC funding for the next two to three years could be in a very strong position indeed, as long as they don't try to face down the cash-rich.